Macro factors not slowing private debt in Australia - AVCJ Forum

“I am still getting inquiries for new credit exposure; people are open for business,” Andrew Ashman, head of the Asia Pacific loan syndicate at Barclays, told the AVCJ Australia & New Zealand Forum. “What you generally see in Australia is a bit of a time lag from volatilities impacting global markets and generally the market is a bit insulated to the volatility you see elsewhere.”

Barclays was involved in Australia’s first covenant light transaction in 2015 when Apollo Global Management acquired Leighton Holdings’ maintenance services business. Around a dozen investors covered the financing for the deal on a buy-and-hold basis. Since then, the number of participants has proliferated, with global debt funds pursuing Asia expansion, the emergence of local debt funds, and greater interest from institutional investors in Australia and elsewhere in the region.

Cov-lite structures – which usually feature an incurrence covenant that is only tested when the borrower takes certain actions like issuing new debt or engaging in M&A – are a feature of term loan B (TLB) deals. Financial sponsors can also expect flexibility on dividend payments and investment in capital expenditure and a bullet repayment on maturity after seven years instead of gradual amortization. However, they must pay more than for a traditional bank financing package, with Ashman putting the pricing at 450-500 basis points over the bank bill swap rate.

Unitranche is the other option, which combines senior and mezzanine facilities into a single debt piece. Arriving in Australia in 2017, they are denominated in local currency and occupy the middle ground in between bank and TLB financing in terms of pricing and flexibility: lighter covenants than banks but not TLB cov-lite; more leverage than banks but not as cheap. HPS Investment Partners offers 5.5-6x debt-to-EBITDA at 550-600 basis points; an Australian bank might do 4-4.5x for up to 300 basis points less.

Gary Stead, a managing director at HPS Investment Partners, which is active in the unitranche space, noted that the impact of issues such as the coronavirus outbreak depends on the nature of the target business and how long the disruption lasts. “We haven’t seen sponsors holding back, we are seeing a lot of activity and processes underway. Will things get pushed back? I can certainly see that happening, at least by a quarter. Does it go beyond that? We have to wait and see,” he said.

Similarly, it remains to be seen whether the impact is limited to a softening on valuations or investors trying to re-trade on existing deals – pushing the multiples down – as they are about to close.

Stead also draws comfort from the presence of covenants in unitranche deals, noting that a breach could be considered a non-recurring event but only for a limited period, so it helps to be proactive. “Having the covenant means if we are about to trip or near trip, we can have a constructive conversation with the sponsor at a point in time where there is a lot of equity value in the business,” he said.

Most business HPS does in the US is now with mid-market private companies rather than financial sponsors, largely due to the level of competition in the market. Most large private equity firms have in-house capital markets teams that are tasked with sourcing the cheapest possible capital on the best possible terms. It has resulted in a tightening in spreads, a dilution in terms, and an erosion in covenant quality. Stead contested Australia has yet to follow this path because there are fewer participants.

The notion of an underserviced market extends into the middle-market, with an increasing number of private companies looking for financing from investment funds. FC Capital is one of numerous players to have entered this space in the last five years, typically providing event-driven solutions for companies starved of capital as banks withdraw from the market.  

“It’s about picking the best opportunities. We kiss a lot of frogs to get some good deals, but there are a lot of good deals out there to be found. I can’t see that changing any time soon because there are so few competing sources of capital,” said Alan Butterfield, who manages FC Capital’s credit opportunities fund. He expects to see more competition emerge as investors recognize the scale of the opportunity, but the nature of the business – writing multiple relatively small checks – means it will remain a niche play.

As for the impact of recent macroeconomic events, Butterfield emphasizes the importance of strong underwriting and applying consistent standards. “There are factors that will impact pricing in certain sectors from time to time – coronavirus, bushfires, droughts. At the moment, tourism is really struggling in Australia, agriculture has been struggling for some time. These are not necessarily short-term, but you keep an eye on them and you may choose to go one way or another.”

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• Topics
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• Buyouts
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